Bank of Canada Seen Holding on Rates, With Possible Dovish Tilt

Canada’s central bank is almost certain to hold the line on interest rates this week, but may kick its dovishness up a notch by flagging greater concern about low inflation while stopping short of signaling rate cuts.

All 12 primary dealers of government securities surveyed by The Wall Street Journal see no change to the Bank of Canada’s benchmark overnight rate, which has stood at 1% since September 2010. Two-thirds expect language similar to December’s rate statement, while the rest predict it may be more dovish, including one who suggests the central bank may even adopt an easing bias.

But none expect the Bank of Canada will actually cut rates when it eventually moves from the sidelines. Ten of the dealers predict rate hikes next year — six calling for the first half of 2015 and four for the second half. Of the remaining two, Deutsche Bank projects a quarter-point rate hike in the fourth quarter of this year, though chief economist John Clinkard said he’s not “quite as tethered” to this view after December’s grim employment report. Bank of America Merrill Lynch, meanwhile, doesn’t expect rate hikes until the first quarter of 2016.

Until just a few months ago, the Bank of Canada was the only Group of Seven central bank flagging potentially higher rates, a stance adopted in April 2012 under then-Governor Mark Carney.

Last October, several months after Stephen Poloz succeeded Mr. Carney, Canada’s central bank dropped the rate-hike signal, citing a prolonged period of low inflation. Then in December, it voiced greater concern about low inflation. Both moves were contrary to market expectations and led to a sharp decline in the Canadian dollar. From near parity before October, the loonie is now trading at multi-year lows against the U.S. dollar

In an interview with the Canadian Broadcasting Corp. two weeks ago, Mr. Poloz said low inflation is his biggest worry. The consumer price index has languished below the 2% target for 19 consecutive months to November, the latest month for which data is available.

Other central banks in the developed world, including the U.S. Federal Reserve, also have to deal with low inflation. The International Monetary Fund on Tuesday warned of deflation risks in advanced economies, with consumer prices expected to stay below target “for some time.” Last week, IMF managing director Christine Lagarde likened deflation to “the ogre that must be fought decisively.”

Central banks typically cut rates to stoke prices when inflation is low, but some economists argue that the pace of economic growth in Canada doesn’t warrant rate cuts, especially when the U.S. and broader global economy are strengthening .

“They (Bank of Canada officials) have to be very nuanced. They have to say their forecast is more or less in line with the beginning of the transition (to an export-driven economy) they’re hoping for,” said Stefane Marion, chief economist of National Bank of Canada. He’s among those looking for a similar tone to the December statement. But, “they can’t say there’s a full-fledged transition,” as that “would reignite rate hike expectation,” he said.

According to Bank of Nova Scotia’s vice-president of economics, Derek Holt, it would take a combination of a weak housing market, continued soft inflation and soft export growth to prompt a rate cut. He said the central bank would also want to avoid sharper currency depreciation.

“I don’t think they would want to commit themselves strongly just yet,” though the rate statement may sound “incrementally dovish,” Mr. Holt said.

Economists said central bank officials likely welcome the Canadian dollar’s weakness, which is expected to help boost exports and speed up the elusive rotation to an export-driven economy.

“The Bank would like to make sure that the Canadian dollar doesn’t take off again,” said Carlos Leitao, chief economist of Laurentian Bank Securities in Montreal, who is looking for more dovish language Wednesday in the wake of December’s gloomy employment report. He believes the central bank may even adopt a “conditional easing bias” by signaling rate cuts are possible if inflation stays near the bottom of the target band.

The central bank’s rate decision is due out at 10 a.m. EST Wednesday, along with the quarterly Monetary Policy Report that will include updated economic forecasts.

Paragraph 10 of this post has been corrected to say it would take a combination of factors to prompt a rate cut. The original post said rate hike.

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